Thursday, September 26, 2013

Suppose a friend tells you that in 1945 their grandfather paid $5,000 for 150 acres of land in Telluride, Colorado. Then they ask you, “how much is that in today’s dollars?” I think to most people this is a really straightforward question. A quick Google search should give you the answer (I came up with this link). To most people, there is a single multiplier that allows you to convert 1945 dollars to 2013 dollars; you just have to look it up. The link I found tells us explicitly: “$1 worth of 1945 dollars is now worth $12.99.” But I find this question really difficult.

I recently read Titan, Ron Chernow’s excellent biography of John D. Rockefeller. The book has lots of passages like the following:

Rockefeller gave $100 million to the Rockefeller Foundation in its first year, bolstered by another $82.8 million by 1919. In current dollars, that would translate into a $2 billion gift during the foundation’s inaugural decade. (566)

Chernow does not explain how he makes this or other calculations. But every time I read a phrase like that I thought, what does that even mean? What does it mean to “translate” 1919 dollars to 2013 dollars? What we care about is the claim of money on real resources, but it’s rarely clear which resources are the relevant ones.

I had similar thoughts last week when Census released median income numbers for 2013. “Wonks” dashed off blog posts proclaiming that the middle class was better off in 1989 than now and that recent decades represent a “lost generation” of economic progress. These comparisons were based not only on ignorance of composition effects but also on the assumption that CPI-U-RS, which the Census Bureau uses to provide constant-dollar time series, is the correct way to “translate” 1989 dollars to 2013 dollars.

Ultimately, my problem is with how the question is posed. The wonks who abused the income data think they are answering a question about economic welfare; they are therefore assuming that CPI-U-RS can turn dollars into utils--measures of welfare. That’s a bad assumption, of course--welfare is about the benefits people get from things, not just the price they pay. No price index can capture changes in welfare over time. Most of our price indexes, to some degree, allow the consumption basket to change over time; so they measure the cost of buying the type of consumption basket people want to buy--or the market value of total output produced--at each point in time. If people get richer over time (in truly real terms), they are likely to change their consumption basket in a way that could make their “cost of living” go up even while their welfare increases. To get even an ordinal approximation of the change in welfare over time we must either fix the consumption basket in 1989 and measure its cost in 2013, or fix the consumption basket in 2013 and find its cost in 1989. This latter exercise will be impossible because many of the things we consume now did not exist in 1989--but that’s the point. It’s hard to compare welfare across time when many of the goods that give us utility now weren't in the choice set 25 years ago (or even five years ago). At the very least, these numbers should be converted into labor hours for the relevant worker, in the style of Don Boudreaux and others; but even that won’t tell the whole story.

To decide whether you really believe the wonks, ask yourself the Garett Jones question: if Doc Brown’s DeLorean shows up at your door and offers to take you to 1989 and give you a job and income that would put you in the same national percentile as your current income, would you take the offer? Was the quality of medical care, transportation equipment, computers, and communications technology in 1989 good enough to make you better off? I think the honest answer for most people--probably not all, but most--is no. And if the answer is no, then our price deflators aren't delivering welfare measures, at least over many decades (by the way, I played with some other deflators on the income data, and some do make the data look better--but none make the data look great).

What about the other questions--the land prices, or the 2013 value of Rockefeller’s charitable activities? Again, we must be more careful about the question.

Suppose I were to respond to my friend’s question about land by using a local land deflator. In some contexts, that would be the correct approach--but it would defeat the point of the question at hand, which is to illustrate that the old man got a great deal on the land since Telluride real estate is now out of reach for everyone but Tom Cruise. Maybe a wage denominator is the right tool here--how many hours did grandpa have to work to make the purchase, and how many hours would a person in the same occupation have to work to buy that same land now? The person asking the question needs to be more specific than just, “how many dollars is that today?”

The Rockefeller question is really tricky. For a time span that long, and for the transaction in question, I don’t think there is a standard deflator that will tell us anything useful. In fact, I don’t think there are many questions that can be answered here. A price index would tell us very little--we don’t have great price indexes going back that far, for starters, but also the consumption basket of 1920 is nothing like the consumption basket of 2013. Few of the jobs people do are even similar. And no, Ron Paul has no solutions for us here--even if the U.S. dollar had been on a constant gold peg this entire time, knowing how many pounds of gold Rockefeller donated would tell us almost nothing important.

Really the question we want to answer is, “is that a lot?” We can only answer that question in rough, vague terms. With Rockefeller-sized numbers, maybe we can put nominal GDP in the denominator and see how much of national output Rockefeller gave away. Maybe we could use an outcome-based result: Rockefeller’s charity led directly to several disease cures and universities; how much do we value those things now? (By the way, during his lifetime Rockefeller gave away much more money than just his Rockefeller Foundation endowment).

I don’t find any of these approaches satisfactory; at best they can hint at magnitude. Maybe we should just convert everything into apples or pounds of (constant-quality) beef. The point is that I don’t think dollar comparisons are very useful when they’re made over long periods of time. It depends on the question, of course--we can often deflate figures with hours of labor--but many questions don’t have answers. At the least, I think writers should be more aware of how their measurement of the cost of living affects their conclusions.